HUBZone Program: Court Decision Highlights “Fracture” Policy

The SBA will not aggregate a HUBZone applicant’s employees with the employees of the applicant’s affiliates for purposes of determining compliance with the “35% rule,” but only if the SBA determines that there is a “clear line of fracture” between the HUBZone applicant and its affiliates.

A recent decision by the U.S. Court of Federal Claims highlights an important SBA policy, which isn’t codified in the SBA’s regulations but can have a tremendous impact on HUBZone Program eligibility.

The decision of the U.S. Court of Federal Claims in Lawson Environmental Services, LLC, No. 15-1550C (2016) involved an EPA procurement for environmental remediation services.  The EPA issued the solicitation as a competitive HUBZone set-aside.

After evaluating proposals, the EPA awarded the contract to Coastal-Enviroworks Joint Venture.  Lawson Environmental Services, LLC, an unsuccessful offeror, filed a HUBZone status protest.  Lawson alleged that Enviroworks, one of the joint venture’s members, did not meet the HUBZone program’s “35% rule.”

Under the SBA’s regulations at 13 C.F.R. 126.200(b), for a HUBZone company owned by U.S. citizens, “[a]t least 35% of the [company’s] employees must reside in a HUBZone.”  But the regulations do not explain what happens when a HUBZone company has an affiliate.  For small business size purposes, the answer is clear: under 13 C.F.R. 121.106(b)(4), a company’s size under an employee-based size standard includes the company’s own employees and the employees of all affiliates.  But does the same princple apply in the context of the 35% HUBZone Program requirement?

Lawson argued that Enviroworks was affiliated with two non-HUBZone companies and that, including the employees of the affiliates, Enviroworks did not meet the 35% HUBZone residency requirement.  The SBA disagreed.  After reviewing relevant documentation, the SBA determined that there was a “clear line of fracture between Enviroworks and [its affiliates].”  Therefore, the SBA held, the employees of Enviroworks’ affiliates were not considered in the 35% analysis.  Because 4 of Enviroworks’ 11 employees lived in HUBZones, Enviroworks satisfied the requirement.

The SBA’s HUBZone Program website provides additional details about how the “clear fracture” rule works in practice.  The SBA provides this example:

For example, Company A is not qualified for the program. The owners of Company A set up Company B, with a few employees, most or all of whom are HUBZone residents. Company B lists a principal office location in a HUBZone and seeks HUBZone certification. Both Company A and B are in the same line of work. When Company B gets a contract, it uses Company A’s employees, equipment etc. Or, it subcontracts all or most of the work to Company A. In these situations, the SBA has used the totality of the circumstances to determine that the employees of Company A are actually employees of Company B (or vice versa). As a result, Company B may not meet the principal office and/or the 35% employee HUBZone residency requirement when the employees from Company A are added the to the employees from Company B.

The website also includes a link to a HUBZone Certification webinar, which provides additional information about how the SBA determines whether a “clear line of fracture” exists for purposes of applying the 35% rule.

By the way, the HUBZone component was mere background information in the Lawson Environmental Services case; the Court’s ruling turned on a different issue.  But because HUBZone protests and appeals are not publicly published (unlike SBA size, 8(a), and SDVOSB appeals), I’ll take any public information that I can get about how the SBA is applying its HUBZone Program rules in practice.  And in the case of the 35% rule and affiliation, the SBA’s practical application is of especially important since the regulations themselves do not address the issue.